A creditor with a contingent claim in a chapter 11 case has a strategic decision to make: By filing a proof of the claim or participating in the case, the creditor may submit to the jurisdiction of the bankruptcy court or lose the right to a jury trial. So, a creditor will sometimes elect not to file a claim and forgo whatever protection the claim and the chapter 11 plan might afford.
A January 30 decision by the Fifth Circuit shows that sitting on the sidelines sometimes doesn’t pay off.
The debtor built a large manufacturing plant in Louisiana with proceeds from a bond offering underwritten by a broker. The debtor soon encountered financial problems: The bonds went into default, and the debtor filed a chapter 11 petition.
The underwriting agreement gave the broker indemnification rights against the debtor.
Although the debtor had not scheduled the broker as a creditor, the broker was aware of the chapter 11 case but did not file a claim related to indemnification rights. As Circuit Judge Dana M. Douglas said in her opinion for the Fifth Circuit, the broker “never participated” in the chapter 11 case.
The bankruptcy court confirmed a chapter 11 plan. The plan barred anyone with a claim from asserting any right of setoff or recoupment. The plan also created a trust into which the debtor transferred its remaining assets and rights of action.
One year after confirmation, bondholders assigned their claims against the broker to the liquidating trust. The claims alleged misrepresentations by the broker in the sale of the bonds. With regard to the bondholders’ claims, the underwriting agreement gave the broker indemnification rights against the debtor.
The liquidating trust sued the broker in state court for violating state securities laws. Based on the indemnification agreement, the broker filed a counterclaim against the trust for setoff and recoupment.
The liquidating trust responded to the counterclaim by filing an adversary proceeding in bankruptcy court followed by a motion for summary judgment to knock out the counterclaim. The broker filed a cross motion for summary judgment, asking for relief from the confirmation order under Rule 60(b).
Bankruptcy Judge John W. Kolwe of Lafayette, La., ruled in favor of the liquidating trust, enforced the plan as written, barred the broker from raising affirmative defenses against the trust based on the indemnification agreement and refused to amend the confirmation. When the district court affirmed, the broker appealed to the Fifth Circuit.
Knowledge Is Enough
Circuit Judge Douglas first dispensed with the broker’s argument that the plan didn’t apply to it because it was not scheduled as a creditor.
Citing familiar authorities, Judge Douglas ruled that the broker “is nevertheless subject to the confirmation plan because of its actual knowledge of the underlying proceedings.”
No Plan Modification
Even if the plan was enforceable, the broker contended that the bankruptcy court should have modified the plan under Rule 60(b).
Judge Douglas found no abuse of discretion in refusing to modify the plan given Bankruptcy Judge Kolwe’s finding that the broker was “fully aware” of the chapter 11 case and did not take action.
‘Speak Now or Forever Hold Your Peace’
The broker made numerous arguments to the effect that the plan was invalid under the Bankruptcy Code. Even if the plan was invalid as to the broker, Judge Douglas said that the “trust is not the appropriate party against whom to raise its setoff defenses,” because the broker could only assert setoff against the debtor.
If the broker had objections to the bondholders’ assignment of claims to the trust, Judge Douglas said that the broker “could have raised those concerns” while the plan was in process. “[R]aising them now, several years post-confirmation, is too little, too late,” she said.
Judge Douglas affirmed.
Observations
With the benefit of hindsight, the broker could have filed a proof of claim based on indemnification claims against the debtor, although the validity or amount of the claims would have been in doubt before confirmation. The broker could have attempted to muck up confirmation and might have obtained some relief with regard to indemnification rights.
The bottom line is this: It’s best to confront potential problems rather than sweep them under the rug, hoping they won’t reappear.
A creditor with a contingent claim in a chapter 11 case has a strategic decision to make: By filing a proof of the claim or participating in the case, the creditor may submit to the jurisdiction of the bankruptcy court or lose the right to a jury trial. So, a creditor will sometimes elect not to file a claim and forgo whatever protection the claim and the chapter 11 plan might afford.
A January 30 decision by the Fifth Circuit shows that sitting on the sidelines sometimes doesn’t pay off.